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October 02, 2008

A common problem I've noticed with potential disruptors is that they have initial success breaking through the noise with a disruptive idea or a disruptive message supported by underlying authentic persona or product, yet as soon as they get the attention they so desired, they start to be criticized by the mainstream pundits for being different or lacking in some respect. So, they immediately tone down the disruption and start trying to appear mainstream, middle-of-the-road, mediocre and above all, not different.

This happens with companies all the time as they mature. They do what MBA schools everywhere teach you to do. You had a disruption. You quickly moved to market leader. Now milk it for maximum profit.

To many, this means optimizing internal efficiency of the business, stripping out costs and uniqueness (because uniqueness carries a cost) to produce goods and services with the highest (theoretical) margins possible. There is a rush by competitors in a marketplace to copy each other's features in a race to the middle where all rough edges are sanded off, nothing is controversial, nothing is extreme. Everyone runs focus groups (which, by the way are worse than useless for pointing to the future and helping with disruption), and all the focus groups tell them exactly the same thing, so they adjust their messages and features and benefits to conform to a mass mediocrity with features that no one really values. All this to maximize their market and appeal to the broadest possible audience. Ironic, isn't it?

This is the conventional wisdom. Get noticed for being different. Move to the middle mainstream as fast as possible. Unfortunately, when it comes to disruption, the conventional wisdom is almost always wrong.

Without a doubt, if Mr. Obama wins the presidency, he will usher in a new post-racial era in American socialization. It will be no small accomplishment for the first African-American candidate to reach the pinnacle, and become the world's most powerful leader. He has promised change, and certainly in the early days of his campaign, the media and methods by which he delivered that message seemed to resonate as authentic and pure. He had disruptive convictions, and disrupted the primary process. He came from behind as the dark horse visionary, upsetting the Democratic party establishment to win the nomination. He got people excited.

All was going swimmingly, when suddenly a new disruptive force was thrown into the fray. Governor Palin has succeeded by disrupting and disarming at each step of her political career. Unseating incumbents for mayoralty and governorship, taking on her own party's establishment by going direct to the people and espousing a populist message that resonated. Unseat corrupt politicians. Throw out fat cats. A hockey mom indeed, with both charm and grit. If the McCain ticket wins, she'll be the first female vice-president, a populist voice from an outsider state, and will change presidential politics forever just as Obama will if he wins.

Both Obama and Palin were effective in disrupting not just because of their color or sex (although those characteristics are highly symbolic of the change each represented), but because there was authenticity behind the message and symbolism. Neither sought approval of the political establishment, but went direct to the people with powerful ideas representing radically different directions.

Enter Mainstream Spin Doctors and "Handlers"

When disruption is successful, it starts with an unmet or underserved need in the market. The electorate is tired not just of the idiotic "sound bite" bickering in Washington, not just of George Bush, not just of the inability of Congress to get anything done except make sure they break for holidays on time and get their indexed paychecks and pensions, but increasingly of the lack of vision, lack of principle, and destructive actions or inactions that have gotten the country into the mess it is.

Perhaps the most intensely partisan don't feel this way, but certainly everyone without party allegiance does, and many who identify themselves as conservative or liberal, republican or democrat, do as well.

How bad is it?

For the past two weeks, our country's financial system has been on the verge of a train wreck, mostly caused by Congress pushing Fannie Mae and Freddie Mac to be social tools of government, putting poor and high-risk people in houses they couldn't afford. This pressure from Congress resulted in a bonus system set up in those quasi-governmental corporations which highly incentivized executives for the number of loans underwritten to the poor, rather than the financial prudence of those loans, which of course led to massive corruption and a blind regulatory eye. Corruption in false appraisals, unethical mortgage brokering, fraudulent resale of bad paper, and the packaging and hiding the trail of all those bad loans into securitized products that we all got suckered into buying unknowingly through our 401(k)s and mutual funds. Criminal all around, and not much different from the engineer of a passenger train in LA who caused the worst train accident in American history by texting on his cell phone instead of watching the signals.

While this financial train wreck has been gathering steam, political "leaders" have tried to put together a bailout package, initially that completely picked the pockets of the American taxpayer, but without any upside or guarantees that credit markets would unfreeze. Going through several iterations, it's now almost palatable, but still a horrific penalty for those of us who had nothing to do with it to pay. People like me, in fact, who borrowed responsibly, had significant equity, didn't use my house as a piggy bank, and will never get a penny of relief -- the great hard-working and responsible middle-class being ripped off by both the rich and the poor. And, for what has seemed like an eternity, and with another 10-15% of stock market value erased, politicians have dithered, spending their time blaming each other while claiming to seek a bi-partisan solution.

I suspect there are a lot like me who would just as soon seen the entire house and senate fired and replaced with new blood. Unfortunately, that can't happen. But that zeitgeist is what creates the great unmet and underserved needs of the voters.

We need honesty, integrity, authenticity, people who are working for us rather than themselves. People who aren't trying to line their pockets with lobbyist dollars. People who genuinely want to fix Social Security and the tax system, eliminate corruption, defend the country and its freedoms appropriately, regulate as necessary to ensure fairness and consumer protection, but not over-regulate. Eliminate the dependence on foreign energy supplies that not only threatens national security, but introduces immense instability into our financial markets whenever some tinpot dictator wants to throw his weight around. Throw the entire health system in the garbage and start over. And lead with vision, creativity, thoughtfulness and energy.

We need disruptive change.

So that's the foment into which we have not one, but two potentially disruptive choices thrown. At first, Obama seemed fresh, new, articulate, genuine, of the people. He used modern tools like blogs and texting to go direct to the people, bypassing the political establishment. As a result, he generated excitement and fanatical fervor. He disrupted the Democratic party establishment and ultimately won the nomination over the hands-down favorite, Hilary Clinton.

McCain, yesterday's maverick, lacked energy and appeared dispirited and fast on the way to losing. Of course, he had an albatross necktie in George Bush, the most unpopular president ever, but that didn't account for his own relegation to the sidelines as old news while Barack seemed the heir apparent.

McCain knew that he needed a disruption of his own, and went with the brilliant choice of Governor Palin as his running mate. Another fresh face, untainted by Washington politics. High energy. Another historic choice, guaranteeing that no matter who wins the election, we will either have the first black president or first woman vice president. She shook things up quickly with her personality and charm and track record.

Then they got "crammed" by the mainstream

Obama was first. He became imperious, arrogant, above the people not of the people, elitist, clamping down on innovation, touting the party line and the same repetitious negative mantras we've come to hear from every politician before him. When questioned about specifics, he dodged the questions, having been advised by handlers apparently that all he had to do was say nothing to win. Saying something affirmative about his plans was a risk. When challenged, he began changing his position on every issue of significance, moving towards the middle, but in a non-specific enough way that we now have no idea what his intentions are if he wins. All the positive energy of change, the disruption of authenticity, of talking and listening to the people, of any semblance of integrity was lost in very short order. The mainstream owns Obama, and any likelihood of disruptive change was flushed down the toilet. He's just another political hack who wants to win at any cost.

Next was Palin. This has been painful to watch because it's happened so quickly. She was disruptive because she was of the people. Her accent was annoying to many, but undeniably of a place. Many mocked her as sounding stupid, or said she was inexperienced, but in reality it was mainstream carping, both from the political establishment and the media. Her accomplishments actually were the sort that matter to the electorate. Balancing the budget, reducing expenditures, selling off unnecessary luxury assets, attacking corruption. All the while succeeding against the odds -- unseating an incumbent governor from her own party from the position of mayor of a small town. Palin was the living embodiment of Ms. Smith Goes to Washington.

Most of all, what the people, as opposed to the elites, liked about her was her authenticity. She didn't know everything, by any stretch, but that didn't matter. She was trustworthy, not because she had 30 years of experience with foreign governments or because she knew how to work the backrooms and do corrupt deals to move legislation along, but because she didn't. Amazingly accomplished in her short career, untainted, she had demonstrated real leadership, and an ability to take on challenges bigger than herself and win. The kind of leadership that's been missing in Washington for a few generations. Heck, she could have been running for president for all the masses cared.

But then the handlers got a hold of her. She wasn't allowed to change her convention speech script, which quickly made her sound contrived and programmed. She was locked away from the media to be groomed so she'd know exactly what to say and how to handle the gotcha questions. And the net effect? When finally allowed out of the room to do an interview, she didn't sound herself. She was too cautious, too much "on message", too scripted, yet not well enough prepared. In a few short weeks, the mainstreamers stripped her of the number one quality that made her popular -- her genuineness, her hockey-momness, her rural up-country sound and attitude, her authenticity.

Dissatisfaction is Run Amok

So, the things we most liked about Obama and about Palin are mostly gone now. Obama has no chance of redemption -- he is thoroughly a politician, cut from the same cloth as all that came before. Disingenuous, contrived, manipulative, truth distorting, vote chasing, deceiving, power-hungry, willing to say or do anything to win. No longer any potential to disrupt in any way. We saw this most plainly in his and House Speaker Nancy Pelosi's message manipulation around the financial crisis to finger point at the republicans while claiming they were the ones being bipartisan. Excuse me, Ms. Pelosi -- bipartisanship, by definition, is a two-way street, both sides share in credit and/or blame. You can't be bipartisan if you're blaming the other side. I resent you playing games with the financial health of my country to gain political points. And, rather than assume a leadership role, which would have involved some risk, and by the way, proved that he had what it takes to be president, Mr. Obama chose to "phone it in". They just don't get it.

Ms. Palin has gone a long way down the same path, as her stumbling in the media interviews clearly demonstrates. But she has one last chance to disrupt this election in the vice presidential debate tonight. If she returns to being herself, is willing to speak off the cuff, throws off all the trash that's been loaded on to her by McCain's handlers, and is willing to make a mistake or two to make a point, then she will disrupt, and I predict the McCain ticket will win because of it. If she does not, they will lose.

Hard to believe it all comes down to this, but that's the way disruption works. You gotta be authentic. You gotta know what you are and be true to it. You can't be everything to everyone, unless you want to be nothing to anyone. Yup, I said it first. This is Governor Palin's election to win or lose, and it all comes down to whether she's given in to the mainstream, or whether she chooses to go with what got her there in the first place and disrupt the status quo.

My advice to Sarah? There is no shame in being who you are and making a mistake that takes you down in defeat. There is a lot to be ashamed of if you sacrifice your integrity because you think that's what it takes to win. Go back to square one, and be yourself. The electorate still wants change, and will vote for the side they think can deliver it and truly represent them with, regardless of the last two weeks. If neither side offers genuine change, then the Democrats win by default, because it was always theirs to lose.

It Works the Same for Disruptive Innovators in Business

You have to start with a product that resonates. You have to meet an unmet or under-served need. Both Obama and Palin resonated with the electorate, although in very different ways. Then, you've got to stay true to your message. If you are the creator of the most desired and elegant products on the planet, as Apple has become, then you have to keep doing it. That's what your audience values, and it's why they buy from you. If Apple were to drop a bomb on the market like Microsoft's Vista, how long do you think we'd respect them for? You can't race to the mainstream middle and still be a disruptor. You have to continue to resonate.

Full Disclosure Section

I am a supporter of neither republicans nor democrats. I'm that elusive independent sort that everyone is chasing. And, that's why all this matters. Those who are allied to one or the other party have already made up their minds, and they are split 50-50. And, that's why disruption is playing a role. It's people like me that are going to decide this thing, and we don't care about political dogma, in fact, we despise it. The sooner you stop repeating the same tired lines, drop the "speaking points" and tell us what we want to know, the more likely you are to win. And, don't forget the genuineness, authenticity, integrity, trustworthiness, leadership, and being willing to stand for something and mean it.

July 09, 2008

A little over a year ago, Howard Schultz, then chairman of Starbucks wrote an internal memo lamenting the loss of Starbucks' distinctiveness and wondering whether in the mad rush to expand and grow ever more operationally efficient (as measured by speed and same-store sales increases, rather than quality of experience), the company had lost a bit of its soul. This memo was reported in all the major business papers and spurred a flood of blog postings from Starbucks critics and fans as Schultz seemed to have captured what was on everyone's minds, although still at that time, a largely unspoken feeling.

I too wrote an article taking a very different slant and documenting how and why Starbucks had allowed itself to evolve from being the market disruptor to the disruptee as a number of major foodservice chains began to compete on many of the now commoditized (and watered-down) features of the Starbucks experience -- better quality coffee, much lower price, more inviting workspaces to stay the afternoon and work or lounge, free WiFi, faster service and so on.

Through the remainder of 2007, it became increasingly clear that the days of heady growth, at least in North America, were indeed over, and that Starbucks competitors were taking direct aim at the weaknesses in Starbucks' business model armor that had crept into their operations over the preceding 10 years. The company still looked healthy on paper, with year-over-year revenues in 2007 22% ahead of 2006 and record net income (profit), but trouble signs included dramatically slowing same-store sales growth which had clearly reached a limit, and a large number of customers opting for the improved, more widely available and cheaper coffee solutions of the competition as I predicted in last year's article.

Additionally, by the end of 2007, long-time Starbucks loyalists were increasingly grumbling about what was wrong with the company and voting for change by going less frequently, or going elsewhere entirely.

Hello. My name is Howard. Remember me?

As if sensing that the tide of success was turning against his prodigy, Schultz moved back into the driver's seat at the company he built in January 2008, reassuming the CEO role and announcing a return to the basics of Starbucks vision and identity. While acknowledging that the competitive landscape was different, Schultz asserted that the problems at Starbucks were internally generated for the most part, and that the solution lay in self-examination, putting the primacy of the customer experience first again, and getting back to the core mission that had made Starbucks successful in the first place.

In last year's article I identified several signs of disruption and difficult decisions for Starbucks to avert or at least parry with the competition disruption that Starbucks own mistakes had enabled (although in their defense and viewed from an internal "operations" perspective, these would have been perfectly logical innovations to improve efficiency, profitability and leverage the brand through extensions). These included:

pre-bagging coffee beans to preserve freshness (in the process, killing the distinctive coffee smell of an authentic neighborhood coffee bar, and the sensuality of sounds and sights such as scooping of beans, weighing and pouring them into custom bags, etc.)

expansion of chain to be almost as ubiquitous as McDonalds (turning them into a "true chain" experience, common but still expensive)

conversion from manual expresso machines to automatic to improve speed, efficiency and consistency of coffee making (at the expense of smells, theatre and "hand-made" quality)

undoing the conversion of coffee bars into retail emporiums, restoring the "third place" ambiance and experience

improving training

getting rid of automatic espresso machines that made Starbucks just equal (in perception) to the lower-priced competitive options for many consumers

acknowledging that new "low-end" disruptors (McDonalds, Dunkin Donuts, local gas stations) selling fresh-brewed espresso at 25% of Starbucks price changed the game and required a specific competitive response

closing stores because the "coffee aficionado" market was already over-served (in the US market) given "good enough" competition at much lower price points

It's important to note that a few of these are counter-intuitive (at least to most by-the-book MBAs), and options that most businesses wouldn't consider. For example, when I discussed the installation of automatic espresso machines last year, it was noted that the original decision to do this had cost millions of dollars, and replacing them would potentially both slow down service and retire perfectly good equipment before it was fully depreciated and had reached its natural end of life (although the equipment was a "sunk cost", most businesses that had made such a decision in the first place would not easily reverse it and incur additional expenses to restore an "experience" and recreate the lost competitive differentiation.)

The Clover Coffee Machine will elevate the quality and freshness of regular brewed coffee to the premium level that coffee enthusiasts expect, but not so for Starbucks espresso coffees, which will be even more automated than before with the Mastrena, reducing baristas to button pushers. Click on the image to read how the Clover system works.

get rid of breakfast sandwiches by end of 2008 (announced Jan 30), to eliminate strong smells that compete with coffee

slow pace of new openings and close 100 underperforming stores in US (announced Jan 30)

stop reporting on year over year same-store sales growth (announced Jan 30), which could only be achieved in long term by continued dilution of brand experience through increased retailing options

acquisition of The Coffee Equipment Company for its Clover brewing system -- a method which creates a vacuum to suck the steeping coffee through a filter to create an individually brewed cup similar to French press (which pushes the filter through the steeping coffee) to create a superior flavored cup of "traditionally" brewed coffee, with enhanced richness and body (announced Mar 19)

introduce Mastrena espresso makers to replace current generation of automatic machines. (Although Schultz announced this, development of this machine, exclusive to Starbucks, was underway for 5 years.) Billed as enhancing the theater (because you can once again see the barista over its lower profile, and offering more control, it is still an automatic machine whose exclusivity doesn't address the quality and theatre lost with the old manual machines. (announced Mar 19)

Close 600 under-performing stores (up from only 100 under-performing stores in January). 12,000 employees will lose their jobs. (announced July 01)

Overall, the emphasis of these changes is essentially the same as the recommendations I made last year, with the exception of two key points, which I'll discuss below. The stated purpose has been to bring back the sense of theater, enhance the Starbucks experience consistent with brand expectations, put the emphasis back on coffee and hopefully undilute the brand identity. Unquestionably for drinkers of traditionally brewed coffee, the use of Clover machines to individually brew whatever you want from fresh ground beans (rather than chose from one of the three pre-selected coffees of the day) is a large improvement. Closing stores was expected because Starbucks was overbuilt, although Starbucks is blaming closures on the economy.

Is it the economy stupid, or is it really disruption?

For the first time ever, Starbucks has experienced a year-over-year decline in same store sales. The economy explanation has been picked up and widely reported in the media (because it fits the story that they want to report), but we have a hard time believing that Starbucks drinkers are consuming less coffee because of the price of gas. More likely the economy is providing an incentive to the most price sensitive of Starbucks customers to switch to cheaper McDonalds or Dunkin Donuts alternatives, accelerating a trend that would have inevitably have happened anyway, due to the increasing availability of good enough low-end alternatives. Starbucks claims to have done research that disproves this, but we think they'd be wise to ignore the research, which is harder to prove than this more rational explanation. Once people make peace with the mental switch from a high-end to low-end disruptive product rationalizing that the low-end low cost alternative is good enough, they rarely go back.

The two things in the list of strategic changes that Schultz has implemented that are still at odds with "undisrupting" Starbucks are the switch to Mastrena ultra-automatic machines and not fully addressing the low-end threat for what it is.

While the Mastrena may be an improvement in visibility of the barista and enabling them to participate in the experience for the customer, it is still an automatic machine. In fact, it automates more of the process, not less. The supposed expertise of the barista is therefore non-evident -- they can't do any more to improve the espresso shot than can the cashier at McDonalds. The emphasis of the Mastrena is on higher volume (operating efficiency), and any qualitative difference in the cup of coffee between it and the Verisimo machine is so minimal, it is unlikely to be noticed by the majority of caffeine addicts patronizing Starbucks.

This is a key element, because in no way does the replacement of old machines with the Mastrenas differentiate the end product or in the consumers' mind justify the higher price for Starbucks versus their competition. Proprietary is not equal to different, and this is a sustaining innovation that reinforces that Starbucks has overshot the needs of their customers, but yet still underperforms on a key dimension -- the expectation of a quality hand-crafted coffee. An expectation that Starbucks created, but has now walked away from.

Secondly, Starbucks gives the appearance of continuing to be in denial that speed and price are performance criteria that a large percentage of their customers deem important, and that many will sacrifice the brand image of Starbucks to get a good enough cup at McDonalds. Admittedly, this is a very tough line to hold, since through its chain-store ubiquity, Starbucks has ceased to be a unique neighborhood place, becoming instead the middle-of-the-road McDonalds of premium coffee. The only problem is, McDonalds is better suited and better able to be the McDonalds of premium coffee.

How then can Starbucks respond? Can it be different enough to continue commanding a huge price premium over its competition? If not, will business continue to siphoned off by low-end disruptors? Is there a counter-disruptive response that allows Starbucks to not concede the low-end to McDonalds and Dunkin Donuts while maintaining its higher end niche for hard-core loyalists? Will Starbucks realize that the Mastrena is masking the real problem and that by positioning it as an improvement to the coffee experience, may actually lose more customers as it rolls out (if there is no taste difference, has Starbucks reached the limits of innovation in the core experience). Will they recognize that purists want a manual shot pulled, or minimally a semi-automatic (because the barista has more control than with a fully automatic)? Can all these needs co-exist?

While we must praise Schultz for the aggressive return to Starbucks origins and a stronger vision, the question now is has he gone far enough, or is the past year a harbinger of much greater disruption to come? Or, has he recognized that disruption is the problem, and there are more surprising announcements to come as a result?

More importantly for investors, is this the end of Starbucks as a growth stock (SBUX - click to see performance over past year compared with Dow Jone and S+P 500), or at about 1/2 the valuation of a year ago, and still dropping, is it a buying opportunity? Wall Street has been betting against a return to the days of heady growth, but does it have to be that way? I don't think so, but it requires disruptive imagination to see a way out. Perhaps Schultz sees it too.

June 28, 2007

Two days before the official launch of the iPhone, the pitch of media, pundit and public anxiety over perhaps the most anticipated new product since Windows 95 has reached a level only Steve Jobs could properly describe -- Insanely Great! And here I am, contributing to the noise, raising it even a decibel louder if that's possible.

How loud is it? As I finish writing this post, Technorati says that there are nearly 189,000 blog postings (in English -- there are nearly 305,000 in all languages) that talk about the iPhone. Compare that with 39,170 that mention Motorola's RAZR, a phone that was the previous biggest smash hit and which literally put Motorola back in the cell phone business after years of decline. Nearly 6 times the level of mention of a phone which has been exceedingly popular, a design hit, has been in the market since 2004 and which exceeded all other flip phone sales within one year of its release. And, the number of postings that include mention of the iPhone has been rising by over 1,000 every 4 hours today, and you can count on it growing even faster until the pent up hysteria is released at 6pm on Friday. And, the chatter certainly won't stop then.

Think about it -- the entire country seems locked in a heat wave, with most major cities experiencing temperatures in the mid 90s or higher. Yet, people are so lustful of being one of the first to own an iPhone, that they will camp outside a store for 4 days in the sweltering heat to lock in to a 2-year service commitment from AT&T, the worst service provider in the business (more on that later).

So, does all this mean runaway success -- the game is already won? Or, will there be an equal and opposite reaction when possibility and excitement about the future gives way to reality, and inevitable issues with service, availability, bugs in functionality and unfulfilled expectations?

Apple fanatics say it will be successful because it is ultra-cool, easy-to-use, a breakthrough in design elegance and software sophistication. Naysayers say nothing could live up to this level of hype, and that when things die down, sales will appear lackluster no matter how good they are. Virtually everyone notes the stupidity of getting into an exclusive deal with AT&T and warns that this could be the albatross around the iPhone's neck. Almost all of the speculation and predictions are based on visceral and emotional reactions, and influenced heavily by the reality dispersion bubble that surrounds Steve Jobs, and by the majority belief that "better" wins.

But if we run with that notion reductio ad absurdum, what exactly does 'winning' mean? Assuming that the consensus is that the iPhone is a better phone, does it have to achieve market dominance as a late entrant the way the iPod has in the MP3 player space? Surely it doesn't have to match iPod's 80% market share within 5 years! There are over a billion mobile phones already in use around the world. Is a 10 or 20% market share strong enough to be considered successful? (The RAZR's share is only around 5%.) Is this even the right yardstick to use?

The iPhone Will Be a Disruptive Winner

iPhone will be successful regardless of the metrics used. It will be successful beyond the expectations of the most enthusiastic pundits. It will be successful beyond what Steve Jobs thinks. It will be successful in spite of the apparent deficiencies that have already been noted in the reviews. It will be successful despite partnering exclusively with a single carrier, and the one most despised in the industry -- although this will be the biggest road bump the iPhone faces. It will be successful because it will change the game -- actually, it will change many games, and therein lies the secret of its success. It will do all this because it will be disruptive.

But, predictions are dangerous. And, mine disagree with those of many people whose opinions I respect and whose theories I borrow from. Even though I'm siding with the majority who believe the iPhone will be a big winner, how do I arrive at that conclusion and what exactly makes it disruptive?

Who Disagrees With Me

Before explaining what the highly respected experts are missing, let me first say who some of them are and try to summarize their positions.

Innosight

Innosight is the consulting company formed by Clayton Christensen to sell management services around disruptive innovation. Clay developed the original ideas and theoretical framework that underlies disruptive innovation in his series of books - The Innovator's Dilemma, The Innovator's Solution and Seeing What's Next. Saying he (or his minions) have it wrong is like saying that the pope isn't Catholic.

Cingular (now merged into AT&T) is incapable of providing the same high quality, seamless user experience that Apple customers expect

iPhone won't work on 3G high speed data networks -- only EDGE or Wi-Fi is supported -- so there won't be anything unique or distinctive about the wireless service

the deficiencies plus high price point will prevent iPhone from finding a market sweet spot

the approach of Apple is a "sustaining strategy" (i.e. incremental innovation of the cell phone), not a disruptive one, positioned against deep pocketed, long time industry incumbents who have a lot to lose if Apple wins and will fight fiercely for share

He reaches his "not disruptive" conclusion while still finding many things to like, such as lack of keyboard, design beauty, novel interface, thinness and coolness factor.

Mike Urlocker

My colleague, and the CEO of The Disruption Group, has a stronger technology, industry and investment background when it comes to the iPhone, having been the original analyst at UBS to identify the RIM Blackberry as a disruptive product and the first to recommend RIM as a strong buy. Mike has worked for and advised software companies on marketing strategy, and at UBS he was executive director and member of the global technology and telecom teams.

In his Disruption Scorecard evaluation of the iPhone, again shortly after the original announcement in January, Mike rates it a B-, and labels it likely a hit, but not very disruptive. He reasons that the product appeals to people who want status and high design (the coolness factor) and are willing to pay for it, but that it doesn't have much potential to change the game like Blackberry did, or upset incumbent rivals such as Nokia, Motorola or Samsung.

Similarly, Al and Laura (and other pundits too) argue that the natural trend for all products is towards divergence and specialization to better suit consumer needs. They claim the iPod was successful because it was a divergence product. Moreover, they argue that most "convergence" products fail -- convergence being when multiple feature categories are combined in a single product (in iPhone's case, an iPod, cell phone and PDA).

Their position is that consumers prefer products that are optimized to do one task well, rather than a lot of tasks poorly, and they further claim that the iPhone has been over hyped and most over hyped products fail to live up to expectations, therefore the iPhone will be a failure.

Hmmmmm.

Most of the others who claim the iPhone will be a failure base it on their own personal biases rather than what the market as a whole is likely to do and why -- "I'm not going to get one because . . .". Name your complaint here. Price, lack of keyboard, slow data network, AT&T as carrier, touch screen keys too small to hit accurately, it will have bugs in version 1.0, etc.

So, what are they all missing, and more to the point, what is Steve Jobs really up to?

The Label Problem

One of the problems with evaluating anything analytically is that we get hung up on labels rather than thinking about what the labels mean and why the rules of thumb associated with them usually work. In the case of the iPhone, there are many labels and definitions being applied that are throwing people off the scent of what's really happening and my belief is that this is deliberate. Yes, Steve is trying to fool the experts and fly below the analytical radar, ironically while mounting one of the most pervasive and successful hype build ups of all time.

To start with, the name iPhone is a mislabeling. While iPhone does indeed have phone capability in it, it is not a phone. Suspend disbelief for a second, walk with me a little, and it will all make sense soon.

Is your laptop PC a phone because you can make GoogleTalk or Skype calls using it? If not, why not? Does it matter that it isn't the only thing you do with it? What if that was the most important thing you did with your PC, because you make a lot of calls to India, and free long distance service is worth a lot to you? Still not a phone? Well, if your PC isn't a phone, is it a typewriter? I know that the primary purpose for my PC is typing documents, blog posts and html. I print a lot of those on paper. Mine is definitely an evolved typewriter. Or maybe your PC is really a gaming console, or a mobile email device because you use it at home, at work, at Starbucks and at hotels and other wi-fi hotspots around the world to send and receive emails. Or, maybe it's just another example of a highly unsuccessful convergence device? Or, do you still think your PC is something else?

The iPhone is Definitely Not a Phone

So, if you were willing to suspend disbelief and suppose that the iPhone might not be a phone, what is it then? Let's start with why it's called an iPhone. iPhone is both sales positioning and a ruse. iPhone is positioned as a phone because Apple knows that in that niche, the market is sorely lacking for a stylish, easy to use, fun, visual, well-designed and well integrated device. It is a first if only because of its elegance. Don't believe me? Then why isn't it really an evolved iPod? One with a really big screen, beautiful graphics and music navigation, and by the way, it includes the ability to make phone calls?

The reason is because Apple believes this is the purpose that you will understand out of the starting gate, and for which it can convince people to shell out $500 or $600 to get the most stylish and coolest gadget on the block. Therefore it is positioned as a phone, and that's the basis on which everyone is analyzing it, and writing glowing reviews, but it isn't a phone. It's also a ruse, because Mr. Jobs has a much higher goal in mind than selling the world's coolest phone. But this is an effective way to divert attention from the real disruption that is happening until it's too late.

Why This Makes Perfect Sense

Let's get a historical perspective to make a little more sense of this. When Alexander Graham Bell invented the telephone and tried to sell his patents to Western Union in the late 1870s, how do you think he described what it was? No one had a framework to describe how revolutionary the phone would be as a communications tool. If you wanted to talk to someone, you went across the street, knocked on their door, and if they were at home or in their office, you could talk. Initially, outside of the securities industry, people couldn't even understand why they would want a phone. Especially since the first version could only work over short distances due to signal loss on the wires. There was no network, there wasn't any need for communications to be sped up that much and nobody else had one, so how much use was it?

Bell considered the telephone to be a way to transmit voice over the telegraph, and that's why he thought Western Union would buy his patents. Bell viewed the telephone, perhaps one of the most disruptive technologies of all time, as an incremental ("sustaining") innovation over telegraphy. (Western Union viewed it as being worth less than $100,000 since they rejected the offer to buy the patents for that much, although they later tried to buy them for $25 million.) Do you consider your telephone today to be a highly evolved telegraph? If you can imagine that, what about your cell phone, or is it different because it's mobile? What then of the iPhone? Just a space age telegraphy device with no keys or dials?

The important thing to note here is that in the early days, it is difficult to imagine the application and importance of disruptive innovations if they really are, because no one has a framework to understand its value. That's why the car was positioned as a horseless carriage. That's why TV was radio with pictures. That's why the first computer was called ENIAC -- or the Electronic Numerical Integrator and Calculator. That's right, it was a calculator that cost 200,000 man hours to build, $486,804 in 1946, and used $650/hr worth of electricity to sit idle. Some times the original naming belies the importance of an innovation. If not for the need to calculate missile trajectories more quickly and accurately during the war, the first computer might never have been built.

And what of convergence versus divergence? Most consultants and branding experts will tell you that convergence as a strategy almost always fails, because the more things you combine into one, the more compromises you have to make in design, and each individual function is sub optimized at the expense of the whole. In disruption theory, a parallel idea says that as companies continually add sustaining innovations to better meet the needs of mainstream consumers and/or differentiate their products, they eventually overshoot the needs of most of their customers. Convergent products usually exceed the needs of all but a small minority of any prospective customer base. After all, who needs every tool on a Swiss Army knife?

That's the theory, but the reality is that when you try to apply simplistic labels to categories or products and then assign attributes or success factors based on those labels, you can miss the forest for the trees. In the case of convergence versus divergence, this is especially true, since which bucket you assign a product to varies based on whether the combined elements are truly synthesized in such a way that they cannot be separated and provide the same benefit, or whether they are just bolted together and not really integrated to optimize overall performance. Ask yourself whether the combination of radio technology, speakers and a cathode ray tube to make a TV represents convergence or divergence? Is it the evolution of radio, or are the elements synthesized in such a way that they create something truly new? If I turn on the TV, but listen to it from another room, is it still a TV, or is it a radio? Did the TV fail because several technologies converged? What about personal computers?

So what is the iPhone, and what is Steve really up to?

It's a handheld one of these

The iPhone is disruptive because it isn't really a phone, or for that matter, an iPod. If it was either of these, then as cool and elegant and nicely designed as it is, it would still just be an incremental or "sustaining" innovation.

Remember that the iPhone has a complete version of the Mac's OSX operating system embedded, plus it lacks a keyboard and has a truly novel interface with seamless integration between different functions. With all that, it can be considered as the first truly personal handheld entertainment and communications computer. It can also be considered the first handheld business computer powerful enough to replace a notebook for road warriors tied of lugging all their paraphernalia through airport security. In other words, it competes in a different class of products -- not as a phone, not as a smart phone, and not as a computer.

It serves the un- or underserved need for lightness, simplicity, ease of use, true integration and is simple enough that my mother could use all the features without thinking about each being a different application or device. Competing against laptops, it doesn't yet have all the applications my PC has, but it is "good enough" that many will be ready to give it a try. And, there are already numerous applications you can download to enhance the functionality for your needs, and many more business applications (especially things like bluetooth connectivity to a real keyboard, document editing, spreadsheets and presentation capability) which will run in Safari are likely to come. And, when compared to a laptop, it is disruptively inexpensive. Analogous statements are true if you evaluate it as a personal communications and entertainment computer.

This is, I think, what the huge excitement is about. People innately sense that this is much bigger than a phone, they just aren't yet able to articulate what is significant about it, and how we'll look back on Friday June 29, 2007 as one of those days when everything changed.

And, it looks really cool and I desperately want one.

Steve's End Game

The iPhone is a trojan horse. Steve lost the first battle between the PC and the Mac because he was less sophisticated as a business person in those days, and didn't fully appreciate how difficult it would be to convince the masses that they needed an expensive personal computer before they had even used one at work. In 1984, the Mac exceeded the needs of most potential customers, and looked like a toy to business (unless your business was about graphics or publishing). The DOS-based PC was the "good enough" disruptive innovation of its time because it catered to mainframe users used to buying computing equipment from IBM and used to looking at green-screen character-oriented terminals.

This time it's different. Almost all of us use PCs daily. And, most of us are tired of the now clunky-seeming interface which isn't much different or easier to use than the initial Mac interface of more than 20 years ago. And, we desperately need a single, small pocket-sized device that can handle all our business needs while on the road and enable us to leave our 10 pound paperweights at home. Something that's easy to get through airport security, and makes my life less complicated.

Moreover, at the price point of $500 or $600, this is something that every road warrior can afford today, if only as a style accessory. So, the decision won't be made or inhibited by corporate IT departments. Sure, they'll try to block connectivity to their servers on security grounds -- they always do, because they think computers are about them, not about the users' needs. Of course, the iPhone includes VPN connectivity, and most have already got their heads around that. But so many executives will have these that just like the Blackberry before it, corporate acceptance will be very fast. And, once you've adopted the iPhone as your traveling computer, how much of a jump will it be to make your next notebook/desktop for office use be a Mac?

My Prediction

As a phone, the iPhone will be exceedingly popular. If production can keep up with the demand, I believe that Apple will sell more than 2 million before year end 2007 -- if they can scale fast enough and have a new version out in time for Christmas, maybe as many as 5 million. Steve Job's stated target is 10 million sold by end of 2008. Given that there will probably be at least 2 more versions of this product before that, I believe 10 million is a very low estimate, set so that expectations can be smashed -- again, it will depend how fast production can gear up to handle demand and support several different models, but 20 million should be easily reachable.

As additional business applications start coming online, probably early to mid-2008, expect sales to really take off. We will no longer be judging the iPhone as a phone when that happens, but as a true micro-mini sized PC which revolutionizes the entire tech industry and rejuvenates innovation throughout Silicon Valley. At that point, the iPhone will disrupt Blackberry, Nokia, Motorola, Microsoft, Samsung, and maybe even Nintendo (to name a few).

And, what about AT&T? Well, that truly is the fly in the ointment and Steve's Achilles Heel. AT&T is brutish about customer service, slow to innovate and slow to reform. They will try to extort every possible advantage in pricing and contractual obligation that they can. AT&T knows nothing if not how to exercise a monopolistic advantage.

Moreover, AT&T lacks the broadest service coverage, and no single carrier (in the US, at least) is right for everyone. We all know that signal strength and dropped calls vary based on where you spend most of your time. So, if you live in an AT&T dead zone, tough luck. Their EDGE network is slow, and they don't have anywhere near complete enough coverage with their 3G services (which aren't built into this version of the iPhone anyway).

It's hard to understand why Job's wouldn't let the market decide if he wasn't going to lease his own service. With a single carrier that many will be unhappy with, Apple will take the brunt of service complaints -- if I could go anywhere, I'd blame the carrier, not Apple. Verizon has the best coverage and fewest dropped calls. T-Mobile has the best customer service, best rates, and happiest customers. Maybe AT&T (Cingular at the time) was the only one willing to play ball on the technology changes that Steve wanted.

Regardless, if service complaints and customer mistreatment stories start hitting the press, expect a negative backlash that could take a serious bite out of sales growth and long term success. On the other hand, wide scale Wi-Max is a technology whose time may well have come -- it would make perfect sense for independent Wi-Max providers to bathe cities in their signal, and then AT&T could become almost irrelevant in the equation (if Wi-Fi VOIP capability exists).

May 22, 2007

Ok, I'll admit it. I too have guilty pleasures. American Idol is one of them.

Back when AI first began, I studiously ignored it. My wife got hooked by the third or fourth show, but I thought the whole idea was dumb and never bothered. The first show I sat through was the finale of the first season, which I thought was pretty pathetic. I hated both singers. They were too amateurish, and although Kelly Clarkson was clearly better, that was only because her competitor was soooooo bad.

Then came the second season. My suspicions confirmed by the first season finale, I ignored the first 5 or 6 weeks. Then for some inexplicable reason, probably boredom, I sat through a show because my wife was watching it. Then I got hooked.

It was still like watching a train wreck happen for many of the below average contestants who couldn't sing in tune or remember their words, but the Ruben - Clay thing was kind of interesting, and I enjoyed seeing the bad singers get voted off one by one. I think that was about when AI started to become the ratings juggernaut and pop star-making phenomenon that it is now.

So, I haven't watched every show since then (not a total addict), but I have come to anticipate my regular fix.

Becoming "The Establishment"

Over the past several years, American Idol has grown in strength, kicking the butt of every show that dares to go against it. America got more and more hooked. Viewership for some regular season shows now approaches Superbowl ratings, and the finale has become so big that it completely encapsulates pop culture. Prince's appearance on last year's finale confirmed the acceptance of AI as part of the establishment and TV royalty. Other than the Superbowl and Y2K New Year's Eve party, what other shows has Prince participated in in recent memory?

Pop stars line up to release new songs or new albums or rejunvenate dead careers on the show. Other TV shows covet the spots before and after AI's time slot, and all FOX has to do to create a new hit is let it follow AI for a few days. New movies are released by offering boondoggles for Idol participants. Actors with new movies out show up in the audience just to be seen. And, they'll pay anything just to secure a seat in the studio audience if they haven't got something to promote. The Today Show, the leading morning Infotainment program routinely reports the previous night's Idol results as one of the top three lead news items of the day -- results from a competing network's "reality" show! Virtually every major media outlet now announces the American Idol results on a weekly basis.

Yes, American Idol rules the roost, but trouble is on the horizon.

The Sweet Sound of Disruption

So, with all the money and star power and publicity and seemingly ever-increasing ratings, how can I say that American Idol is being disrupted? Simple -- the best pure singer the show has ever had, with a voice equal to any pops-topper of the past 40 years, was voted off last week. Amazing. How could this happen?

Why I Might Be Wrong

Many will say that the voters are always right. If the two left are the ones who collected the most votes, then they must be the best, or the most exciting, or have attracted the best following. Especially with over 60M votes being cast -- more than the totals for any presidential election ever.

But realistically, is that possible? Or more to the point, why did Sanjaya last so long? Clearly he forgot words, sang out of tune, and was often just ridiculous. Yes, lots of little girls liked him. Yes, he had a built-in core demographic of Indian voters who had never had one of their own to vote for before. But would that have been big enough to keep him aloft into the top 7?

So what explains it then? An unholy alliance. The crying little girls were part of it, and so was the Indian demographic. So was a group who truly found him entertaining and refreshing and thought he as a good singer. But the influence that tipped the balance could only have come from a blog which encouraged its readers to all get behind the very worst performer left and try to keep them alive week after week.

Vote for the Worst was a little subversive blog site that started in 2004. Having all the right qualities to grow with viral explosiveness, it now has a readership that at its peak this season averaged 500,000 hits per day (coincidentally, that peak occurred in the period when Sanjaya seemed to be invincible, and the media started questioning why such a bad singer was able to survive week after week, while better singers were being voted off.

The graph above clearly indicates that votefortheworst.com had the intended affect, and was responsible for ensuring that Sanjaya survived for several weeks past when he should have. So, they had their good fun, and with the vote distributed between lots of candidates and those near the bottom being particularly vulnerable, a small boost in vote is plenty to alter the result and keep the weakest contender alive. But that doesn't explain the ouster of Melinda, clearly the best and a strong judges' favorite. As the vote totals rise, and the number of finalists goes down, shouldn't that increasingly favor the best?

Moreover, what proof do I have that the vote was close?

The extra information we need comes from DialIdol.com. DialIdol provides software which enables avid voters to speed dial their Idol votes from their computers. In addition to helping fanatical young voters get the maximum number of votes recorded for their choice in the allotted time, DialIdol also records how often a busy signal is obtained when trying to vote, and uses this to predict the most likely winner and loser on the theory that the more often the number is busy, the more people are trying to cast votes for that individual.

Close Voting Favors the Disruptor

In the week that Sanjaya was voted off, DialIdol accurately predicted the bottom three, including that Sanjaya would be loser. In all preceeding weeks, he was safely in the middle. Last week, as the graph above indicates, the voting was too close to predict vote ranking for anyone. So, either the audience didnt agree with the unanimous assessment of the judges and most observers that Melinda knocked it out of the park, or something was helping the poorest singer to stay alive.

Impact of AI Disruption

FOX network at first denied that VFTW was having any impact. Then, when it was clear that they were having an impact, FOX called them "hateful" and "mean-spirited". Ironic accusations from the show that deliberately calls out the most delusional and sometimes mentally-challenged entrants to callously make fun of them in the beginning-of-season reject shows. But mean-spiritedness is surely what the FOX execs feel who rightly understand that the long-term health of the franchise is at stake, and that the sham that American Idol built upon is being exposed and therefore the business model threatened.

What sham?

American Idol is positioned as a contest to find the best undiscovered young (amateur) singer in America, thereby "discovering" them and making them into a star. But that basic idea is a lie. The audition process is not designed to find the best singers, but the best contestants for a reality show.

Of course, the producers want a decent singer to win at the end, so they put "judges" in place to try to guide and influence the public voting. In any given year, there are about 3 or 4 who are actually good enough singers to deserve a recording contract, so as long as the show eventually whittles down to 2 or 3 of that group still standing, and generates a built-in fan base and familiarity to sell records they've won. In the mean time, the show needs to provide entertainment, and a pure singing competition would get awful boring awful fast. Admit it -- we all watch because we like the train-wrecks, because there are crazies who make things funny, because we like to see bad singers insulted by Simon, and we like to see them insult Simon back and then take their medicine by getting voted off.

But, and this is a very important 'but', it isn't a real singing competition until all but the last 2 or 3 have been eliminated.

Here's another way of looking at it. Does anyone really believe that out of more than 100,000 auditions, there are only 4 or 5 people who can carry a tune moderately well? In the general population, there are at least 2 or 3 per hundred selected at random who can sing. If those 100,000 were selected randomly, there should be a couple of thousand potential contestants. But they self-select, which means they either believe they have some talent or just want to be on TV, but that still means that the ratio should be more like 4 or 5 out of 100.

But, the audition process skims most of the crowd, looking either for good personalities for the finals, or oddball personalities for the "audition" rounds, which are highly staged for TV. Either way, it is TV presence that matters, not singing ability. After all, out of 15 to 20 thousand people in any given city, only about 10-15 get on TV, and most of those get the TV spot so we can laugh at how bad they are. But the show would have us believe that outside of the few who are picked for Hollywood, everyone else is mediocre or less.

VFTW exposes this sham. They recognize that American Idol wants train wrecks in the final 12 to keep the show entertaining while we get to know the "real" finalists. Which is why there are so many in the top 12 who can't sing. VFTW agree that it's funny, so they want to keep the train wrecks on as long as possible, and in the process they are slowly but surely eroding the premise that the show is based on by exposing the lie that it really isn't about finding the best singer. And, they need almost no resources, no money, little time -- just a small blog to undermine the show's foundation.

That's why poor Melinda lost last week. That's a personal slap at her, but it may end up being the straw that broke the camel's back as far as the show is concerned. AI didn't care who she sang against, but everyone wanted the best singer to be in the final.

So, the real cost of disruption is that America starts to realize there is a wizard behind the curtains trying to manipulate them into picking who they always wanted us to pick, and once we realize we've been fooled, we lose interest, they lose their star-making machine and the billions of advertising dollars and promotional opportunities that the show has spawned.

And the outcome may be that VFTW forces a change in process which makes the show more honest but less interesting. That's a real world example of the power of disruption -- either way it costs and it may kill the target if the response to the threat isn't met successfully.

Nobody said that all disruption was good.

Food for Thought

Could FOX or American Idol's producers have anticipated this?

How should they have reacted to the disruptive threat?

Is there anything they could still do to neutralize it before next season?

How would you know if the crown jewel of your business was about to be disrupted?

Can you deliberately create disruption like this to upset your competitors (in an ethical and legal way)?

The memo itself was an interesting document that raises eyebrows and questions: although addressed to the president and other senior execs, was it always intended to be leaked via social media, into the mainstream press and back to the blogosphere? It has certainly created a lot of passionate commentary and free advertising for Starbucks. Was it really intended to tell the public that Starbucks knows that people are complaining and that the competitive sands are shifting? Was it a message to investors that the company needs to slow growth and fix the experience to save the brand and that it's going to cost a bundle? Or was it just the confessions of a founder and Chairman, purging feelings of guilt about a loss of soul, and a plea to executives for salvation? (Which, incidentally made Starbucks look good while rallying those who are still passionate about the brand experience to Starbucks' defense?)

No matter which of these it was, it was a brilliant document, but it may be too little too late.

Too Little, Too Latte? Starbucks is the World's Pre-eminent Coffee Brand: How Can it Be So?

It really depends on whether the executives realize that disruption is afoot, and that there's much more going on here than the diminution of brand experience. To properly address this question, and explain why disruption is the real problem, it helps to go back to the beginning, and define the innovation that led to Starbucks becoming a household name approaching 15,000 stores around the world.

What problem did Starbucks solve for its customers?

Anyone who travelled in Europe BS (Before Starbucks) would have marvelled at the quality and variety of coffee, and the cafe culture there. Especially in places like Italy and France. The coffees were strong, but fresh, well-prepared and a perfect complement to a day of sitting on a sidewalk under an umbrella people-watching, or to end a perfect meal, or a delightful jolt to start the day with a pain chocolat or even just toast and eggs. You would have wondered how everywhere you went, coffee could taste so strong, yet be so delicious and universally good. On this side of the pond (outside of your favorite Little Italy restaurant), it was almost impossible to get a decent cup of coffee, and especially to get a strong cup that was drinkable. I remember wondering after every trip why it was that good coffee on our side of the pond was an oxymoron whilst on their side, it was impossible to get a bad one.

It wasn't just that most (North) American coffees were made from Robusta versus the superior Arabica beans. It also had to do with poor roasting, poor quality control, and the fact that we got used to crappy coffee during the second world war when everything was rationed and/or watered down. By the 50s, everything was about speed and automation, and so we made matters worse by going from percolated to instant to freeze dried to Coffee-Mate powdered creamer (another oxymoron). We drank it by the gallon, rotting our stomachs, taste buds and brains in the process. It was purely about the caffeine and the speed. (Wonder why we never distilled out the caffeine and dispensed it straight via injection?)

Yes, in a few big cities, you could find that rare place that would serve a great European-style coffee, and sometimes even with a bit of the ambiance, but that was so small a percentage of consumption that it barely qualified as an exception to the rule.

The story is apocryphal, and published on Starbucks website, and in Schultz's book, about how Schultz felt exactly this way on visits to Milano, and decided that it was time Americans got to upgrade their coffee experience. And, not just create a better cup of coffee, but the same smell and feel and cultured experience and ambiance that you felt in a great Italian coffee bar. That was the beginning of Starbucks as we know it.

We'd been upgrading the experience for ourselves, as much as we could with drip coffee becoming more the norm in the 70s and 80s versus instant, but the vast majority of Americans had never had a quality cup of coffee nor enjoyed the sensuality of the European coffee culture. So, when Starbucks hit Seattle, we were ready for something different.

So What About Disruption?

Disruption theory says that products or services evolve incrementally to better meet the needs of the most demanding customers, but eventually overshoot the needs of most consumers. In this process, the incumbents that dominate the existing market build processes and operational efficiencies that enable them to maximize profitability and continually introduce new "sustaining innovations". In the short term, these series of decisions that improve processes and efficiency are seen as good management, delivering better profits. In the long term, however, they create the opportunity for a disruptive innovator to enter the scene.

At the time when Starbucks began, the big coffee suppliers had enormously overshot the needs of their customers for a cheap, fast cup of coffee. Yet, each "innovation" they introduced kept on making the product either cheaper or faster to prepare, stripping the product of the original reasons we became addicted to it - its flavor first and foremost, but also its ability to facilitate social interaction, savor a great meal, sit and relax, etc.

So Starbucks was a disruptive innovator. It brought flavor, a friendly social setting (the "third place"), quality, plus the consistency that only a chain can do. They brought back the smells, the sensuality, and introduced to Americans a "European experience" -- and, what Schultz has described as the sense of theater.

But, you might be saying, Starbucks introduced a high-end innovation -- disruptive innovations typically are aimed at the low end markets and low end needs. Well, you'd be right, but the question is: what needs were low end, or more accurately underserved. The characteristic that initially made Starbucks a small niche disruption was the speed. The big producers were optimized for speed above all else, not flavor and certainly not the organic pleasure of a gathering place with great smells where you hang out with your friends.

The characteristic of Starbucks' innovation that was just good enough for the original niche of coffee culture appreciators was the speed. They were happy to sacrifice the speed of picking up a pot of coffee off the Bunn burner (ironic that they called these things burners, because that's what they did/do to most pots left longer than 5 minutes) and pouring it straight to the cup and from there to the lips, in order to drink something they truly enjoyed, and to experience the coffee bar ambiance.

Initially, potential competitors to Starbucks ignored them because the market wasn't big enough for Dunkin Donuts or McDonalds to care about. To them, Starbucks coffee drinkers were aficionados -- a tiny specialized segment that had nothing to do with the mainstream, who they perceived still mostly wanted speed.

This ignorance is typical (and logical) to mainstream vendors who aim to maximize profit by serving the largest market as efficiently as possible. It also allowed Starbucks to "fly under the radar" for a long time -- over 20 years of strong growth -- allowing them to build their market unimpeded by real competition (yes, there are smaller chain coffee brands, like Caribou and Peets, etc., but their presence serves to expand the market for all specialty coffee vendors, and benefits the leader, i.e. Starbucks, disproportionately) until they became the mainstream and were perceived to be a real threat to the foodservice business of other big companies.

But Starbucks is the leader and still growing. What's this about Disruption?

As noted, disruption can take a long time to play out, and the seeds are sown long before the heavy damage is done. As Starbucks has grown, they have focused on operational efficiencies to grow faster and more profitably. Efficiencies such as automatic espresso machines, flavor-sealed packaging (which eliminates the great smell of a real coffee shop), and expanding merchandise options ("would you like some fries with that doppio mocha latte half-caf with low fat milk?") to extract every last penny of same-store sales growth. In the process, they have incrementally sacrificed seemingly small parts of the experience -- the smell, the theater, the ambiance (who wants a line snaking around the tables while you're trying to relax or have a conversation over a cuppa?), the service quality (rapid growth almost always comes with higher turnover and poorer training -- by now, we've all experienced the surly baristas who won't go the extra mile, but still make too many mistakes), etc. In the process, they've reduced themselves to serving a pretty-good-but-not-outstanding cup of coffee, too slowly and at too high a price.

And, more importantly, they've overshot the needs of their customers, and are ripe for disruption. To speed up coffee service in order to sell everything else too, they installed automatic machines. Automatic machines can be more consistent, especially for inexperienced operators, but they also reduce the flavor and the authenticity of the experience, and show competitors how they too can produce a cup just as good as Starbucks (i.e. open themselves to commoditization). This was an unnecessary and ill-advised "innovation". Customers didn't ask for it, would probably agree that they didn't need it, and in general would feel that they are getting less for their money. Do I really need a bacon and egg (McMuffin) breakfast with my espresso? Again, the more I overlap with my competition, the more I illustrate to them how to compete with me. And now I smell eggs cooking, not coffee beans and fresh espresso. Not wise. Most fanatical customers who still are, were more fanatical 10 years ago, so what have these innovations added?

In becoming ubiquitous, the mystique is demystified, the coffee which was the central feature has become a means to sell myriad other food items and irrelevant merchandise (t-shirts anyone?), and the taste and smell and comfort have all been diminished. Yet, the high price remains. And, therein lie the seeds for potential disruption.

Because now, wanting a good cup of coffee has become mainstream, and Starbucks has become focused on speed (but not really), and efficiency, and foodservice, and add-on sales and rapid growth, they now face a new reality. Its easy to add a pretty good cup of coffee to the menu. Especially for companies like McDonalds and Dunkin Donuts who already served coffee. All they have to do is add middle-of-the-road or better automatic machines to their operation, and they're almost as good. But, they excel at real speed and efficiency, and are optimized to process customers in seconds or at most a minute or two, whereas Starbucks will never get that fast without redesigning every store and adding a lot more baristas. Moreover, they are value-oriented -- i.e. cheap. For McDonalds, $1.25 for coffee is an improvement in margin, but for Starbucks, it's impossible to go that low. So, if I can get something almost as good for 1/3 the price, is that 'good enough'? Heck, even the the local QuikTrip service stations can create a relatively decent cup of coffee or espresso now.

And, more than commoditization, Starbucks' real problem now is that the competition is 'good enough' to be disruptive and undermine their business. But here's the real conundrum Starbucks faces. It will be almost impossible to go back.

Replacing the automatic machines with better quality semi-automatic or manual, and fresh ground and hand-tamped shots means throwing out a lot of expensive machines. It means they will go a bit slower for each coffee, which also means they'll need more people and more space for brewing. And, they'll need to increase their training expense enormously.

It will be hard to explain to investors why all the superfluous merchandise needs to come out of the stores, and why same-store sales will likely decrease. It will be even harder to recognize that for the mainstream coffee consumer, a $1.25 cup of coffee is good enough, even if I can't quite bring myself to visit McDonalds, and so there will be increasing downward pressure on price. If they don't want to compete on price, then they probably already have too many stores, because the average consumer won't continue to spend a premium price for a commodity that is only marginally better than the competition.

Coffee Customization at Its Finest

To Schultz's credit, he recognizes that all is not well. And, he's recognizing it at a time of apparent strength. Starbucks just announced another record year where revenue grew 23%, 1177 new stores were added, and same-store sales increased 6% over the previous year (although the rate of increase is slowing, these are still impressive numbers for a $6.7B company. If he can convince his executives and board and investors that a strategic overhaul is required to address the looming disruption, then he may well be able to avert it, but it isn't as simple now as returning to the good old days of better quality machines, better service, less merchandise, whole beans scooped out of bins rather than prepackaged in flavor-sealed bags, more uniqueness in each store, etc. They will need a plan designed specifically to address the disruption Starbucks faces from new competitors, or else the disruptor will become the disruptee.

Acknowledging that the market has changed irrevocably, and is now attracting disruptive 'good enough' solutions for quality coffee, but at a lower price and faster pace, what would you do to re-energize Starbucks and fend off a loss of leadership position in the coming years?

Microsoft employee Cesar Menendez (and Zune team member) says that the information he originally gave that Medialoper reported on was incorrect, Zune doesn't add DRM to the music file, but it still only allows another Zune to play it 3 times in 3 days. Nice semantics. It's not file-based DRM, it's device-based DRM

I think I wasn't harsh enough in labelling Microsoft's DRM-team as intentional evil doers (see below). It's worse than that -- they're trying to sell something that is horribly consumer unfriendly, and maybe even breaks the law, as if it was a benefit. And the paeons they have doing the work don't seem to have a clue.

Here's a marketing strategy! Why not refuse to implement DRM under any conditions and make a big deal about it in a public statement and in marketing programs? Microsoft is big enough to challenge the music and movie industries, and if they made a principled stand by simply releasing Zune without DRM restrictions, they could actually have a disruptive innovator's chance of whipping Apple at their own game. Not only that, they'd push the industry into something that's good for them -- lower priced goods distributed 100% digitally.

It might take a while, but when the industry saw how popular the devices were with consumers, they'd get on board. Nature abhors a vacuum: we'll switch to a completely different business model for getting our music, bypassing the industry entirely, or suck up tons of bootlegged material since no one wants to sell it to us legally at a reasonable price.

History has shown over and over again that unencumbered, or with reasonable licensing, every technical advance original feared and fought by copyright holders has actually created greater opportunity for profit. There's no reason to think this is any different.

Other Related Zune Notes

Urlocker is skeptical that Zune has what it takes to "change the game". Correctly points out that unless Microsoft disrupts the market, it will not attract sufficient users to make it viable, let alone successful. Definitely no disruptive innovations here.

eHomeUpgrade say it can't believe that Microsoft is so arrogant to have designed Zune to be not PlaysForSure compatible, meaning that any old content wrapped using Windows Media technology and purchased through Microsoft partners such as Napster, Rhapsody or Movielink will not be playable. This definitively illustrates my point that DRM is a poisonous and evil technology that will eventually bite us all. It also proves beyond any doubt that any vendor that has that kind of control will eventually use it to harm their customers, regardless of what they say publicly.

You probably don't care about copyright, patent protection and IP rights, or if you do, you may have a simple notion that the things protected by IP are ordinary property that their "owners" have the right to control for personal (or corporate) gain indefinitely. I'm going to take an unpopular position and try to convince you that:

a) This is a false view, largely based on the successful positioning and campaigning by corporate interests who control rights to music, art, literature and more general IP (patents, software, drug chemistry, etc.)

b) That IP rights are not absolute.

c) That the most recent manifestations of copy protection in the form of Digital Rights Management (DRM) are insidiously evil, and harmful to future advancement of technology, the arts, commerce and society in general.

d) That ordinary people need to speak up and be heard. It is through our inaction, and only through our inaction that corporate IP pirates and special interests will abrogate the last of our rights and expropriate our common birthright for their own gain.

e) This matters in both philosophical terms and in real losses of freedom and privilege. There is a direct economic cost to each and every one of us -- like a tax, except that it goes to corporations who are acting against our common interest as a civilization. Not only does our collective freedom as a society depend on it, but the future success of the capitalist economy that we have lived so richly from. (Most corporate interests would have you believe the opposite, but it is they who are taking apart the foundations of the free enterprise system, and killing the goose that has laid the golden egg.

Paul, you're confusing me. What are you talking about?

This posting was inspired by Robert Scoble's recent blog entry from last week which discusses a "Channel 9"video with the WAVE (Windows Audio Video Excellence) team from several months ago while he was still at Microsoft. For some reason, the interview did not get posted at the time it was made, and has only recently surfaced. Although much of the interview is about some interesting fault tolerance features that make the user experience with Vista quite a bit superior to XP and before, there is a significant chunk in the middle which discusses Digital Rights Management (DRM). DRM is more popularly known as "anti-piracy" technology by the music and film business, a convenient term coined by the industry that paints themselves as the victims, and the rest of us, their customers, as the villains.

In his post, Robert describes the WAVE team as the "most evil team at Microsoft". He was speaking in jest, which became apparent in the firestorm of emotional commentary that followed, when he rapidly backtracked and called the team good people who are "just responding to a business request". I hear the faint distant echos of military apologists who claimed "I was just following orders."

OK, I think I know what DRM is. Why should I care again?

So, we know that DRM is about protecting copyright in various digital media, from CDs to DVDs to software to eBooks to iTunes downloads and more. Isn't this just about keeping dishonest people from stealing copies they haven't paid for? No, in fact it isn't. It is mostly about limiting honest people from exercising their "fair use" rights to things they've already paid for, but more about that in a bit.

Quick history of copyright

In America, Congress was empowered to create national copyright and patent laws by Article I, Section 8 of The Constitution which says:

[The Congress shall have power to] promote the Progress of Science and Useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;

Some key points here:

The purpose of copyright is to promote Progress of Science and Useful Arts. That is, by giving a limited term exclusive right to profit from creative work the intent was to balance the common good with an incentive to the create artworks and invent/discover new science.

There is a subtle, but very fundamental observation at the root of this abstract concept of IP protection. Namely, that all advances, all creativity, all technology is built on what came before. Without a wheel, we couldn't have a cart, which couldn't become a horse drawn carriage, which couldn't become a car. In art, imitation isn't just flattery, it is a long tradition that many of the greatest masterpieces drew on the work of previous art masters. Some of the most contested copyright cases, such as Eldred vs Ashcroft which challenged the constitutionality of the Copyright Term Extension Act (CTEA) passed in 1998, are at their core about this concept of the need to build on past achievements in order to have progress. CTEA was sponsored by Sonny Bono, who thought that all copyright should be forever, and was aggressively lobbied for by Disney Studios. It is therefore also known as the Sony Bono Copyright Term Extension Act, and often referred to as the Mickey Mouse Protection Act, a derogatory reference to the primary immediate beneficiary of the bill, namely Walt Disney Studios.

Mona Lisa, perhaps the most famous painting ever, was created by Leonardo da Vinci between 1503 and 1505. Mona Lisa: LHOOQ was created by scribbling a mustache and beard on a post card image of the Mona Lisa, and labelling it with the letters LHOOQ (intended to be pronounced and sound like the vulgar French expression "She is hot in the ass") as a Dada-ist parody of Mona Lisa by Marcel Duchamp in 1919. Fair use? Free speech? Or, should the artist's copyright allow him to block such "new art"?

CTEA is especially ironic in the benefit it provides to Disney at the expense of "Progress of the Useful Arts", because many of Disney's greatest animated features were drawn from the Grimm Brothers and other fairy tales in the public domain. It has been said that the purpose of CTEA is to stop anyone else from doing to Disney what Walt did to the Grimm Brothers. But the chilling effect on innovation applies equally to all areas of technology invention, pharmaceutical development, publishing, software -- in fact all of the significant areas of intellectual property.

But isn't that what the Constitutional framers intended?

NO. As a matter of fact, they didn't.

When the constitutional framers were considering protection of intellectual property, it was at a time of explosive economic growth and new theories about the free market as an engine for prosperity, freedom and our common good. Not coincidentally, it was 1776 when Adam Smith published his famous paper "An Inquiry into the Nature and Causes of the Wealth of Nations", which discussed the benefits of the "invisible hand" of the free market for the common good. Capitalism was a good thing, and it was argued that by following their own enlightened self interest, the owners of production capacity not only benefited themselves, but created increased wealth and improvements to the common welfare for their communities as well.

It was this free market philosophy and the desire to ensure that there was an economic incentive to the creators of new inventions and art that led to the inclusion of a clause in the constitution to implement exclusive Intellectual Property (IP) protections "for a "limited time". I draw attention to the limited time qualifier, because without it, you have perpetual monopoly control of IP. Where you have a monopoly, you do not have competition, and therefore you do not promote either progress or the common good. Pricing tends to be exploitive and there is no incentive to increase efficiency or reduce cost of production. Without this most basic notion of competition and free markets, we do not have a healthy capitalist system, and the constitutional framers would probably not have granted this privilege of exclusive commercial rights to IP.

An excellent paper by Dotan Oliar affirms this intent of the framers to limit both the period and Congress's ability to extend the period. Having studied the original source documents and the recorded constitutional debates and notes from the framers, he concludes that the original proposal by Madison and Pinckney to include IP protection did not have such a limitation, and that it was specifically added later with the intent to ensure that the common good was not harmed through perpetual rights to IP. Despite this, we have Congress repeatedly passing bills to extend copyright privileges for the 11th time in 40 years, culminating in the Mickey Mouse Protection Act in 1998 and the Digital Millenium Copyright Act also in 1998, both of which severely restrict the consumer's rights to use copyrighted materials that they've paid for, and effectively overreaching the limitations on term specifically proscribed in the Constitution. These extensions clearly benefit only the copyright holder and unquestionably harm the "Progress of Science and the Useful Arts".

How does a limited term to copyright serve to promote the progress of the useful arts?

Let's look specifically at art for a moment. It is a well accepted practice, with millenia of history behind it, that art imitates and changes art. The Romans freely admitted copying the Greeks and Egyptians in their sculpture, architecture and decorative arts. Famous artists learned their craft through imitation, going to the prominent galleries to copy what they saw until they understood it and could add to it, and working in the studios of the current day masters learning their techniques and rules of composition, color and form. And, we aren't just talking about imitation during their learning phase -- they carried on the practice of imitating those that went before throughout their years of accomplishment. Some prominent examples are posted here.

It is no different in music, writing or R+D -- we all build on the body on knowledge that came before. Copyright lawyer and former counsel to the US House of Representatives, William Patry acknowledges this debt to the past in his blog post "In Praise of Imitation":

My college degrees are in music theory and composition, the "and" signifying that I both analyzed what the greats had done and wrote my own pieces. These two processes were, however, rarely separate: much of what I composed was an imitation of what I was studying, and I went through compositional fads related to my then-current theoretical interest. When I was infatuated with the Second Viennese School of Schoenberg, Berg, and Webern, I wrote music with twelve-tone rows, and not being original, I used one of theirs. When later I was into the avant-garde Polish music of Penderecki and Lutoslwaski, I tried to write like them.

Balancing Economic Incentive to Creators and Inventors with the Common Good

As a sidebar, it continues to amaze me how wise, insightful and forward looking the constitutional framers were in understanding subtle effects and the need for checks and balances in the design of this country's governance and legal systems. Protection for IP was almost not included in the constitution at all, yet it was recognized that providing such protection was both an adequate reward and strong incentive to create new technology and art that would power the country's economy for generations. It was a brilliant notion. On the other hand, they also recognized that monopoly power is a very dangerous thing for social systems and is contrary to the common good, and that if granted in perpetuity, it is damaging to economic, scientific and artistic progress.

With the Mickey Mouse Protection Act (OK, the CTEA) and the Digital Millenium Copyright Act, we have managed to allow commercial interests to undermine and render meaningless the balances that were intended to create progress and benefit the common good (which was the orginal reason for the clause to be added to the Consitution). Copyright protection now extends to the authors lifetime plus 70 years. This length of time is clearly beyond any reasonable limit which provides economic incentive to create novelty, and in fact, one could argue that it provides an anti-incentive to new creation. Invention and creation costs money and time and perspiration. If you have monopoly powers to exclusively milk a creation for 100 years or longer (70 years past your own death), why bother creating anything new? If competitors can't use these ideas to advance knowledge and build their own products, eventually virtually all innovation will be under lock and key, and only at the discretion of the rights holders.

Jack Valenti, bagman and lobbyist for the Motion Picture Association of America certainly understood this when arguing for extension of copyright protection. His proposal to satisfy the 'limit' provision with a term of "forever less one day" (yup, it's right there in the Congression Record, Vol. 144, page H9952) clearly demonstrates how he and the entrenched interests of the MPAA felt about advancing the common good.

In the beginning, 'limited Times' was defined as a period of 14 years, with the right to renew for one additional period of 14 years if the author was still alive. Twenty eight years of government enforced monopoly power seems more than ample to profit from an invention, even today.

Back to the Future

So, here we sit in 2006, 216 years after the first copyright law was enacted under the Constitution of the newly minted United States, faced with a copyright regimen that creates monopoly profit opportunity for up to 120 years, or almost two lifetimes, for all intents and purposes an 'unlimited Time', which completely undermines the intent of allowing copyright privileges in the first place. And, beyond that, we now have the DMCA, which further limits the honest user's rights to use materials they've legitimately and legally paid for. The recording industry not only seeks to stop you from moving it between machines (if you do it too many times -- i.e. greater than 5 in the case of an iTunes file -- the file stops working, even though you've paid to use it), but to impose injurious design standards on the machines that you play it on.

Rather than describe the implications of these myself, I am referring to two outstanding descriptions of the insidious evil that we are today faced with. The first is a presentation by Lawrence Lessig to the Open Source Software Convention (OSCON) in 2002, and the second is a manifesto written by Cory Doctorow, which was delivered as a talk to the Microsoft WAVE team discussed at the beginning of this entry. For simplicity, you may also click on the images below to view these items.

What can we learn from this?

China will win. In the beginning of copyright rules, it was the underprivileged classes, including the Scots vs London-based booksellers and US and Irish publishers who ignored English rules and assumed everything was in the public domain. Today, China is telling us that world-imposed IP protections are ridiculous, and that the billions of people earning pennies a day can't afford $5 for a single prescription pill or $379 for a single copy of an operating system. So to advance their economy and standard of living above the poverty level, they are ignoring the extant world system, and building on our advances while we sit stagnant. Where will this leave us in 20 years? 20 years behind the Chinese, and without an industrial or IP base to work with.

Consumers lose when industry lobbies government for its own selfish gain. You have progressively lost the legal right to make legitimate personal use copies of virtually everything through increasing mechanization and digitization of content and Digital Rights Management.

Industry has smarter marketers than the philosophers and end-users. Society has been hoodwinked by clever marketing and positioning. The argument was won in Washington and on the world stage when the MPAA and RIAA successfully labelled copyright protection as "anti-piracy". Why? Because pirates are bad -- they rape your women and steal your treasure and butcher ordinary people. We went along with that labelling, perceiving that only dishonest people could be tagged as pirates, but now we have allowed a walled-garden to be erected around virtually all content, and fair use of copyright material has been practically eliminated as a concept. To win this battle, we must a) fight it, and b) reposition the DRM and CTEA as plunderers of our collective heritage and our rights to continue forward technological, artistic and intellectual progress. It is the Rasputins of the "creative" industries who are pirates and thieves and who have harmed the common good that copyright was initially created to protect and promote.

Enablers may not have evil intent, but they are evil nonetheless.In the 1930s, Germans who did not actively defend Jews from persecution may not have directly harmed the Jews, but by stepping aside and allowing the Nazis to practice their immorality, they enabled it. The kind of evil that turns a blind eye, says I'm just following orders, or "if I don't do it, someone else will" is rationalizing and debasing of the human spirit. Microsoft cannot stand aside and support abrogation of our rights through enabling technology (nor should Apple, but it was Scoble's blog about Microsoft's WAVE team that raised the issue). Bill Gates is willing to go before the Justice department and the EC to fight for years on end about whether or not Microsoft is a monopoly. Why not take a moral stand about consumer rights regarding fair and legitimate use of licensed IP?

This is not an issue of left vs right. I am a capitalist and a strong free market advocate. In my view, allowing unlimited copyright and enabling technology which takes away rights that still exist under the law is anti-capitalist and anti-free market. It destroys competition and makes lawyers more important than innovators, putting a major damper on our country's ability to compete effectively in the future. It is like transnational protectionism, and just as destructive of value and earning potential, except to those who are granted special monopoly privileges. It also has a nasty way of encroaching on free speech. Those on the left side of the spectrum who value freedom, innovation, keeping jobs in America, in promoting the commons and in keeping our country strong should feel the same way.